Student loan debt continues to be a pressing problem for millions of Americans—and not just the millennial generation. Millennials have made headlines in recent years for record debt crippling their ambitions to buy homes, start families, and even move out of their parents’ homes. A less-talked-about issue (but no less pressing) is the parents and grandparents who supported a student through school by co-signing for a private loan or borrowing money from their retirement accounts. There are even heart-wrenching stories of parents stuck making payments on loans for the education of a deceased child.
We may not be able to fix the past, but we can help reverse the trend going forward. Parents and grandparents of young children have time on their side when it comes to paying for college. Like the old adages about retirement savings, the earlier you start putting away money to fund your child’s education, the more time you have to grow that account and help your student graduate debt-free. A college savings plan is an incredibly helpful tool to make sure you achieve your goals.
Step one, however, is taking care of your own financial needs. You shouldn’t take on extra debt or sacrifice your retirement account in order to contribute to your child’s college fund. Remember, there are no student loans or scholarships in retirement, so a big caveat here is to get your own financial picture in order before you put any amount into college savings.
When you’re ready to open a college savings account, there a number of different approaches. Here’s your guide to your options for college savings plans.
529 college savings plans
A 529 plan is like a savings account that receives special tax treatment. Although your contributions are made with after-tax dollars, any earnings within the plan are not taxed. Your contributions are invested in mutual funds or other investments, similar to a retirement plan. When your child reaches college age, he or she can make qualified withdrawals to use for qualified education expenses. As long as the withdrawals adhere to the plan requirements, there are no tax implications. Your child can use the money in the 529 account to attend any qualified school in the country.
Tax implications: You contribute after-tax dollars. Earnings and withdrawals are tax free.
State prepaid tuition plans
Some states, including Florida, offer a special type of college savings plan that covers part or all of the costs of tuition at an in-state institution. Each state has its own requirements; in Florida, you select a plan with payments that go toward future tuition costs at today’s rates. These plans can generally be converted should your child decide to attend a school out of state.
Tax implications: Varies by state, but generally similar to a 529 plan.
Parents or grandparents can open and contribute to a brokerage account intended for a child’s future. The biggest difference here is that the funds aren’t restricted to education. Once the child becomes of age (generally 18 or 21), he or she owns the account and can choose how to spend the money. These types of accounts may offer tax advantages for the contributor.
Tax implications: Contributions over certain amounts may be subject to gift tax considerations. Earnings on the account are subject to income taxes each year.
Yes, a Roth IRA is traditionally considered a retirement account. However, you can withdraw earnings without penalty if you’re going to use those funds for college expenses. Unlike a 529 plan, however, you’ll owe taxes on those withdrawals. If your child chooses not to attend college or doesn’t need the money (e.g. he or she receives a scholarship that covers tuition), the money is treated like a retirement account. Roth IRAs tend to have more investment options than 529 plans.
Tax implications: Contributions are made with after-tax dollars. While withdrawals can be made for qualified education expenses without penalty, the earnings on such withdrawals are subject to income tax.
Coverdell education savings account
If your income is below $110,000 for single filers and $220,000 for married filing jointly, you can contribute up to $2,000 per year per beneficiary to a Coverdell Education Savings Account and deduct your contributions. Earnings aren’t taxed as long as the distributions cover qualified education expenses, and your student can use the funds for either undergraduate or graduate education prior to age 30.
Tax implications: A Coverdell may be a great option for a tax deduction if you qualify based on the income limits.
Start saving early for college
The best advice we have is to start saving as early as you can. Even contributing $15 per month to a college savings plan in the toddler years will add up in the long run and give you a lump sum to invest as your child grows. Try to increase the amount you save each year, and automate your contribution to make sure it’s not inadvertently cut from the budget. When your teen begins considering college options, you’ll provide a solid foundation to help him or her borrow as little as possible. If you need help determining the best account for your situation, contact us to schedule a consultation.